Tonight's FOMC will be an important event for the currency markets. Apart from the continuation of the tapering, attention will be focused on the communication of the guidance and on Yellen's words. The new macro and rate projections will also be presented tonight. The most important issue concerns the timing of the first hike, so under observation will be the phrase that refers to the "considerable time" that should have passed between the end of the purchase program (expected in October) and the first hike.
Possible adaptations of this expression (or its elimination) to herald the approaching turning point could be interpreted as the possibility that the first increase will be brought forward with respect to current expectations which place it around mid-2015. This would cause a generalized strengthening of the dollar, even against emerging ones. If, on the other hand, the verbal passage is softer, the greenback should limit itself to consolidating. Further – and more extensive – appreciation would only be postponed.
EURO
The euro was not in fact affected yesterday by the negative data on the German Zew, and actually rose up to 1,2995 dollars during the day. The real test will however be the FOMC. The less the Fed wants to signal the approach of the first rate hike, the greater the probability that the exchange rate will reappear at 1,30 dollars. However, this would not change the expectations of a subsequent weakening below the recent lows (1,2860 of last week): the fundamentals of the euro area and the United States in fact have room to diverge further.
GBP
The pound is slowly recovering. Yesterday inflation fell, as expected, going from 1,6% to 1,5% y/y (it therefore remains below the target, defined as 2%±1%). This morning, however, the labor market data came in better than expected, with a decline in the jobless and unemployment rate higher than expected. As for the minutes of the September BoE meeting, McCafferty and Weale voted again for an immediate rate hike. The majority, however, remains compact, preferring to wait, because there are still no signs of inflationary pressures and unit labor costs are growing at too low a rate.
The exchange rate also contributes to keeping inflation low, which, despite the recent decline, remains strong. Finally, the deterioration of the situation in the euro area in the last month and the increased geopolitical risks pose downside risks to the growth scenario of the British economy. The pound, which had climbed to nearly $1,6340 prior to the data and reports, has since corrected slightly and is hovering near 1,6300 as of this writing.
However, today's news remains compatible with an initial increase in the bank rate in the first quarter of next year. Therefore, if tomorrow's referendum on Scottish independence does not change the status quo, the pound should start climbing gradually towards 1,65 dollars, barring any disappointment from domestic data. The expectations of a strengthening are also valid against the euro.
YEN
After a brief rebound in the 106 dollar area, the yen fell again returning to the lows of recent days around 107,30 dollars. Kuroda said yesterday that (1) it is natural for the greenback to strengthen if the US economy improves, (2) a stronger dollar is not bad for the Japanese economy and (3) currency movements are not causing problems to Japan. Implicitly this supports a scenario of further weakening of the yen against the dollar at this stage, in the face of growing macro divergence between the two economies. The risk is therefore that the exchange rate could approach 110 dollars faster than expected.
